Treasury Secretary Henry Paulson recently announced yet another
change in direction of the "Troubled Asset Relief Program" (TARP),
sowing more uncertainty and confusion in the very financial markets
the program is supposed to stabilize. Instead of buying
mortgage-backed assets as originally intended, Paulson says he is
now considering three alternative initiatives:

Stock purchases in non-bank financial firms;

Federal financing for investors in securities backed by
consumer debt such as car loans, student loans, and credit cards;
and

Subsidies to mitigate mortgage foreclosures.

Rather than moving forward with these new and troubling
approaches, Paulson should follow his own advice and let the
markets work--including time for them to absorb his earlier
initiatives.

TARP: Then and Now

Less than six weeks ago, Congress enacted legislation
authorizing a massive $700 billion rescue plan for the nation's
financial markets. The goal, as outlined by Paulson, was to prevent
a massive, systemic failure of global financial markets. The
solution, according to Paulson, was a "Troubled Asset Relief
Program" consisting of massive purchases of illiquid "toxic" assets
by the federal government from financial firms so that markets
could continue to function. The focus was widely expected to be on
mortgage-backed securities, whose value was often extraordinarily
uncertain, leading to a freezing up of financial markets.

The ink was barely dry on the legislation, however, when
Treasury adopted a new--and more problematic--approach: directly
infusing selected U.S. banks with capital by purchasing non-voting
preferred equity shares. Granted, Treasury's hand in this was in
part forced by European governments, which paved the way with
massive capital infusions into their own banking systems. However,
the original TARP plan, as envisioned when Congress adopted the
authorizing legislation, never went forward.

On November 12, Paulson announced that Treasury no longer
planned to buy any mortgage-backed securities, except perhaps in
certain targeted instances. Instead, he put forth a number of other
possible initiatives the Treasury might pursue with the $700
billion that Congress authorized, as well as other authorities such
as: purchases of stock in non-bank financial firms; federal
financing for investors in securities backed by consumer debt such
as car loans, student loans, and credit cards; and subsidies to
mitigate mortgage foreclosures.

Paulson's Course Changes Confuse
Markets

These possible moves, however, would likely exacerbate rather
than ease the current financial problem. Not only are there serious
questions about the need for these specific actions, but--and
perhaps more importantly--the uncertainty created by yet another
game plan for the rescue casts doubt on the financial rescue plan
as a whole, its administration, and the prospects for its
success.

Certainly, the Treasury Department can legally forego the
mortgage-backed security purchase program. From the outset,
Secretary Paulson emphasized the dynamic and rapidly changing
nature of the financial crisis, and the need to be able to adapt.
And under the terms of the legislation passed by Congress, although
it was clear that the primary intent was to buy toxic
mortgage-backed securities, the flexibility to purchase other
assets was explicitly provided. Even more clearly, no one would
want to require the federal government to intervene in markets
where its intervention is no longer necessary, as seems to be the
case with the mortgage-backed securities market.

No Bailouts for Non-Banks

Nevertheless, each of the various plans for expanding the
program raises serious questions.

Capital purchases--the acquisition of ownership by the
government in private-sector firms--presents inherent and
inevitable dangers. Already, political pressure is growing for the
government to exercise greater control over the activities of banks
participating in the capital program. Moreover, as Paulson himself
noted, because many such institutions are not regulated and engage
in a variety of businesses, protecting taxpayers would be more
difficult. The Treasury should not extend the capital purchase
program to non-bank firms.[1]

Need for Consumer Credit Bailout
Dubious

The second possible new initiative--the purchase of consumer
credit securities--raises different concerns. Treasury argues that
since the problem has shifted, so should the focus of their
attention. But to justify intervention, Treasury needs to show that
the problems in these markets present a potentially catastrophic,
systemic threat to the ability of the financial system as a whole
to function.

In his statement, Paulson argued that "illiquidity in this
sector is raising the cost and reducing the availability of car
loans, student loans and credit cards." This he said "is creating a
heavy burden on the American people and reducing the number of jobs
in the economy." Such harms are real and should not be minimized.
But they fall short of the sort of systemic threat to the operation
of the financial sector as a whole that led Congress to create the
TARP program. If such a threat is indeed present, then Treasury
should demonstrate this explicitly, and make a clear and compelling
case for such purchases.

New Program for Mortgages
Unnecessary

The third initiative discussed by Paulson--reducing mortgage
foreclosures--is the least well defined. The general goal is to
encourage mortgage holders to modify mortgages on a streamlined
basis, reducing payments for struggling homeowners. That goal, he
said, was to be pursued using leverage gained from mortgage-backed
securities purchases. Now that Treasury has decided not to purchase
such assets, he explained, other means are needed to pursue it. He
did not specify those means, although he said any would require
"substantial government spending."

Yet such a separate program would be unnecessary if, as Treasury
asserts, other actions succeed in ensuring functioning credit
markets. On top of this, there are already many other programs in
place to help homeowners. In any case, intervening directly in the
mortgage market promises only further market distortions, as well
as inequity for hard-working Americans who resisted the urge to
take on debts they could not afford.

Single Most Disruptive Force in the
Global Economy?

The biggest problem with Paulson's announcement yesterday,
however, goes deeper than whether this or that new program is
justified or acceptable. By once more shuffling the deck of
possible interventions, Paulson has jeopardized the very stability
of the markets that he was intended to restore.

Markets need to engage the price discovery process and to clear
transactions. These functions are being hindered by uncertainty
regarding Treasury's next move. In his own statement he
acknowledged as much, saying, "We must allow markets and
institutions to absorb the extensive array of new policies put in
place in a very short period of time."

Unfortunately, Paulson ignored his own advice, sowing the
markets with additional confusion. The constant array of new ideas,
new strategies, and changed courses mean that the Paulson Treasury
has become perhaps the single most disruptive force in the global
economy.

It is time for this to end. Henry Paulson should stop tinkering
and allow the world's financial markets time--and freedom--to
work.

James L. Gattuso is Senior
Research Fellow in Regulatory Policy, David C. John is Senior
Research Fellow in Retirement Security and Financial Institutions,
and J. D. Foster, Ph.D., is
Norman B. Ture Senior Fellow in the Economics of Fiscal Policy in
the Thomas A. Roe Institute for Economic Policy Studies at The
Heritage Foundation.

[1]
Even without formal expansion of the capital purchase program, the
initiative has had some troubling consequences for non-bank firms
as companies rush to reorganize as bank holding companies in order
to qualify for assistance. As a result, otherwise efficient
structures are displaced. This process fortunately should end with
the November 14 deadline for participation in the bank program.
That deadline should not be extended.